IRS scandal could lead to better defining of nonprofit campaign rules

Jun. 8, 2013

Written by

CentralOhio.com

Organizations looking to be exempt from paying taxes on their income have several options from which to select.Here is a look at the rules governing a few of the more common entities.

Entity type

Purpose

Donations tax deductible

Donors madepublic

Ability to lobby

Ability to campaign

501(c)(3)

Public charity

Yes

No

Limited

No

501(c)(4)

Civic league, social welfare, local association of employees

No

No

Unlimited

Limited

527

Political organization

No

Yes

Unlimited

Unlimited

Source: Ohio State University, Loyola Law School, IRS

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In any scandal, sometimes the good gets swept in with the bad.

So as the IRS defends itself from charges it targeted nonprofit groups based on politics, some people have called for an elimination of such tax-exempt entities to make the rules crystal clear for the federal government to enforce.

But in reality, most such organizations have relatively benign purposes — from pushing popcorn in Marion to eating bratwurst in Bucyrus.

Even so, most experts agree that improvements can be made in the rules surrounding these organizations to make them easier to enforce.

Sen. Rob Portman, R-Ohio, said the current scandal is rooted in groups being targeted for their political beliefs, but he said it would be appropriate to examine rules concerning nonprofits and politics.

“Whether it’s a Democratic administration going after conservative groups or a Republican administration going after liberal groups, it’s flat wrong and it takes away everybody’s trust and respect for government when that happens because the IRS is incredibly powerful,” he said. “Having said that, the law itself probably needs to be looked at also because the guidelines as to what constitutes political activity is pretty ambiguous, so I think it should be part of tax reform.”

Mostly routine groups

There are slightly more than 3,000 501(c)(4) organizations in Ohio, according to an IRS database, although some are inactive and haven’t filed returns for years. The tax designation is critical because it is at the center of the IRS controversy and is the one most ripe for groups looking for gray areas in politics.

The designation is meant for civic leagues, social welfare organizations and local employee associations, and the list shows most of the entities across the state are ones people would normally think of when contemplating nonprofit groups. They include Kiwanis clubs, Rotary International organizations and alumni associations.

Those groups historically had been placed in this tax-exempt category because they didn’t necessarily meet the rules for being considered a classic charity organization, said Ellen Aprill, a law professor at Loyola Law School at Loyola Marymount University.

“The IRS has always considered it sort of a catch-all,” she said.

For example, the Chillicothe Farmers Market Association received recognition as a 501(c)(4) organization in 2010. Christie Welch, association board president, said the group’s only revenue comes from membership dues, which amount to about $4,000 a year. She said members sought the nonprofit distinction to be able to use all of that money to help promote the market’s goal of providing locally grown produce to the community.

Unlike the horror stories from tea party groups targeted for scrutiny, Welch said her approval process was “fairly straight forward” and took three to four months. In addition to the tax savings, she said the nonprofit status allowed the group to apply for federal grants that have allowed the market to accept food stamps, now called SNAP.

Brad Hostetler, treasurer with the Mansfield Optimist Club, said his parent organization and other civic groups tried to get a more traditional 501(c)(3) charity designation, but they were denied by the IRS. The groups have been 501(c)(4) entities for decades. The 501(c)(3) designation allows gifts to an organization to be tax deductible.

Gray areas emerge

But while most groups are easily classified into this tax-exempt category, changes throughout the years have created some more difficult decisions for the IRS, said Donald Tobin, associate dean and business law professor at the Moritz College of Law at Ohio State University.

“For most of these groups, it’s not a problem at all,” Tobin said. “It’s when the organizations are trying to engage in this mix of political activity and social welfare, right in the middle of a campaign, it becomes very difficult.”

Traditionally, civic groups filed as 501(c)(4) organizations and political groups filed as 527 groups, known commonly as political action committees. Eventually, rules were added to require 527 groups to disclose their donors, which started the shift to more political social welfare organizations.

The IRS allows these social welfare organizations to engage in some political activity, so long as it is not the group’s primary purpose. But the IRS never created rules determining what “it takes to be primarily engaged in social welfare and not campaign intervention,” Aprill said, creating a significant loophole.

In addition, the Citizens United case allowing corporate donations and the IRS ruling that it wouldn’t apply the gift tax to 501(c)(4) contributions aided the growth in these organizations. These decisions essentially allow people and companies to give unlimited amounts of money to these organizations tax free and without disclosure.

Because of these rules, Karl Rove’s Crossroads GPS is viewed the same by the IRS as the Bucyrus Bratwurst Festival or the Marion Popcorn Festival.

While Hostetler said it was wrong for the IRS to target one group of political organizations, it does make sense to investigate whether all political-leaning groups should be getting federal tax benefits.

“I can understand scrutiny of any organization that would seem to be primarily political,” he said. “I think they ought to try to clean it up.”

Drawing clearer lines

Tobin said experts have been calling for improvements to the 501(c)(4) rules for a decade because there has been abuse by entities filing for the exemption. In addition, he said the IRS has shown it has been reluctant to enforce the rules and incompetent when it tried to do so.

“We need to figure out a way to fix it so people’s faith in non-partisan enforcement in our tax laws is restored while there’s a means of assuring that those provisions are not being abused,” he said.

In the New York Times, Aprill called for creating a new exempt classification for organizations that lobby and expanding 527 rules to apply to all organizations that engage in political campaign activities so they are subject to donor disclosure rules.

Tobin suggested that the IRS change its rules to require 501(c)(4) organizations to disclose their donors, eliminating any incentive for political organizations to use this structure instead of the more political one. Hostetler, of the Mansfield Optimists, said he didn’t think disclosing donors to his organization would hurt fundraising efforts because there generally wouldn’t be any stigma in supporting the Optimists.

Seeing any change in the law would require political will, and Aprill wasn’t confident it would happen even in the wake of a scandal.